Catalyst Russia Country Report 2012

Country Report - Russia
M&A update

Autumn 2012

M&A to increase as companies capitalise on
Russia’s growth
Russia is now a strategically important market for foreign
companies. As the world’s sixth largest economy with
growth amongst the fastest globally and now accession
to the WTO, opportunities across a range of sectors are
significant. This will lead to rising levels of M&A.

The key observations from our research:
The Government is introducing a range of legislative and regulatory
reforms to build on its position as the sixth largest economy. These are
aimed at attracting foreign companies, increasing economic growth and
diversifying the economy away from natural resources.
“Many people seem unaware
The opportunities in Russia are broader than just oil. Over US$1 trillion that Russia is the world’s
is being invested in upgrading infrastructure and US$24 billion invested in
preparation for the 2014 Winter Olympics and 2018 Football World Cup. sixth largest economy and
that unlike some BRIC
Russian consumers have the highest disposable income and fastest
countries, Russia is an open
growth in consumer spending of all the BRIC economies. With almost
three-quarters of the population living in urban areas, foreign companies market in which both large
have been investing in Russia both through acquisitions and directly to and small foreign
benefit from rising demand for domestic and foreign-branded goods.
corporations have made
The most successful foreign companies are those who are locating a lot of money in the
production and distribution in Russia, often using M&A and joint ventures. last 20 years”
We believe this strategy will be used by more companies looking to take
Mark Bond, Managing partner,
advantage of Russia’s economic growth.
Catalyst Corporate Finance LLP 2012

NorthStar Corporate Finance

Country Report - Russia M&A update

Low debt and healthy President Putin “It is imperative that we
trade surpluses encouraging foreign increase investment by
supporting financial 2018 to 27% of GDP.
stability
private investment By 2020, Russia must be
Over the past ten years the Russian among the top 20 nations
economy has undergone a significant
with the most comfortable
transformation to become the sixth
largest economy globally (purchasing business climate”
power parity basis). President Vladimir Putin,
St. Petersburg International Economic Forum, June 2012
Real GDP grew by 4.2% in 2011
compared to global and European
GDP growth rates of 2.7% and 1.5% investment-led growth. President Putin has
respectively. Figure 1 illustrates Russia’s stated publicly that he wants investment in
rapid move up the GDP rankings. Russia to increase from 20% to 27% of
GDP by 2018. The initiatives designed to
Russia has almost no sovereign debt,
achieve this goal represent opportunities
large foreign exchange reserves,
for foreign companies.
moderating inflation rates (currently
5%-6%), a strong labour market Four-year privatisation plan which
(unemployment is currently around may include strategic sectors of the
6%), consumption growth and a economy. Large foreign strategic
positive balance of trade. An increase in investors will be allowed to participate
the oil price has benefited the balance in these privatisations.
of trade which has been positive since
the early 2000s. Raising Russia’s ranking from 120th
(of 183 countries) to 20th by 2020 in the
The size of Russia’s economy, its World Bank’s “Ease of Doing Business”
US$1 trillion geographical scale, high level of GDP and index. Roadmaps for three problematic
disposable income per capita relative to its areas – access to power grids,
infrastructure largely undeveloped manufacturing and construction regulation and customs
investment by 2020 service sectors means there is a focus on procedures – have already been
created.

Figure 1: Russia is now the world's US$1 trillion investment in infrastructure
until 2020. Public and private
sixth largest economy by GDP (PPP) partnerships (PPP) are regarded as
one of the most efficient instruments
$16
1.7%
prospectively in funding projects. The
$14
government is actively looking to bring
9.1%
foreign investment to Russian
$12
infrastructure to develop roads,
$10 rail, airports and utilities.
US$trillion

$8 2011 GDP growth amongst highest

of leading economies Full membership of the WTO (ratified
$6 -0.7%
6.9% in August 2012) which will dismantle
£4 3.0%
4.2% 2.7% 0.7% 1.7%
foreign trade barriers and reduce tariffs.
0.4%
$2
This will help attract more foreign capital
to Russia, boost trade and investment,
$0
promote industrial reform and
s

ina

ia

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y

ian

il
St ted

ce
UK

ly
az
ate

an
pa
I nd

Ita
an
Ch

ss

Br
i

rm

accelerate the formation of a
Ja
Un

Fr
Ru
Ge

transparent and open market
Source: World Bank environment (see page 4).
2


Distinguishing Upgrading infrastructure is a top priority
and Russia is actively encouraging Russia set to become
involvement from foreign companies.
opportunities from For example, Bombardier
Europe’s largest auto
Transportation has signed co-operation market in 2012
myths agreements with Russian rail
manufacturer Uralvagonzavod to jointly
There are several myths associated
develop and sell metros and trams,
with doing business in Russia which
establish local production facilities
we examine below.
and transfer Bombardier technology.

Myth 1: The opportunities in Russia Russia is hosting the 2014 Winter
rest on oil Olympics and 2018 Football World Cup.
Some US$24 billion is being invested in
As the world’s largest oil producer, infrastructure including the construction
much attention has been focused on the of new motorways, railways and tourist
opportunities for foreign companies to gain facilities, and the construction and
access to Russia’s exploration and reconstruction of football stadia in
production supply chain. However, there are 13 Russian cities.
many other sectors which are developing
quickly and have attractive growth Three-quarters of aircraft in Russia are
opportunities. currently foreign-made. While Russia is
building its own fleet of aircraft, strong
Russia’s automotive market is the air passenger growth (13% 2010-2011)
second largest in Europe after Germany means that partnerships with leading
with over 2.6 million new cars sold in foreign companies continue to be vital.
2011. With light vehicle density at just Boeing for example, has a production
250 cars per 1,000 people compared to joint venture with Russian Technologies,
643 in the US, the potential for growth Ural Boeing Manufacturing, through
is significant. As shown in Figure 2, a which it procures titanium parts for
range of foreign manufacturers have the 787 Dreamliner.
meaningful market share. In 2011,
locally-produced foreign brands
Myth 2: Foreign companies can’t
including Ford, Renault and VW
make money in Russia German companies
dominated car sales (40%).
The performance record of foreign
very successful in
companies in Russia is evidence that Russia
Figure 2: Foreign brands accounted success is achievable and meaningful.
for 72% of passenger car sales in For example, E.ON Russia, the electricity
2011 producing arm of the German utility
provider, reported 2011 profits of
25% US$495 million.

20% German companies have been particularly
successful (see figure 3). They view Russia
15%
as a strategic market and have invested
progressively over a number of years.

10%
Companies typically invest in phases,
5%
building on proven demand for their
products and then combining plant
0% investment with strong commitments to
training staff and developing sophisticated
da

i
ult

san

ota

rd
oo

z
KI A
da
t

VW

logistics systems to support component
Ga
ole

Fo
ew
La

na
un

Toy
Nis
evr

Re

Da
Hy

imports and local distribution.
Ch

Source: Ernst & Young, AEB,
Otkritie Capital Research
3


Figure 3: German companies are making a significant
commitment to Russia
Sector Company Approach
Automobiles Volkswagen Locally-based manufacturing in Kaluga.
Significant investment training mechanical and auto-mechanical engineers partly by apprenticeships
at its Kaluga plant.
Currently 4% market share in Russia.

Consumer goods BSH Bosch and Siemens Locally-based manufacturing capability for washing machines, freezers, refrigerators near St. Petersburg.
household appliances
Established logistics center.
Acquired 25% stake in Power Machines in 2006.

Industrials HeidelbergCement €600 million investment in a state-of-the art cement factory in Tula region, TulaCement.
The company will be the only local cement producer supplying high-strength cement types to the
local Moscow regional market, which represents 85% of TulaCement sales. TulaCement will
benefit from the upcoming expansion of greater Moscow.

Industrials Schott Two manufacturing sites based near Nizhny Novgorod, a centre for the pharmaceutical industry in Russia,
producing 590 million ampules and bottles annually for the country’s pharmaceutical industry.

Myth 3: The Russian economy is 25% to 5% by 2018. This will increase
Automobiles, too volatile demand for foreign cars which the
government will attempt to control via
manufactured goods recycling fees and by supporting the
The government has established two funds
and telecoms to to reduce the impact of volatile oil and gas localisation of production for foreign
export earnings on the economy. The brands and the creation of joint ventures
benefit from WTO with foreign producers. For example,
US$60.5 billion Reserve Fund, built on oil
membership and natural gas revenues, ensures the the Russian automotive group Sollers’
financing of federal budget expenses in partnerships with Ford, Mazda and
the case that oil and gas budget revenues SsangYong.
decline. The US$85.6 billion National
Manufactured goods. A general
Welfare Fund, used to support the pension
reduction in tariffs with the average
system, has the ability to lend money to
falling from 10% to 7.8%. Russia has
Russian banks and can be used to absorb
committed to join the information
excessive liquidity.
technology agreement which provides
Membership of the WTO should help to for duty free treatment of relevant goods
create a diversified economy. This binds (e.g. computers) within three years.
Russia to a series of trade rules and
Telecoms. Increased market access
commitments which should create a more

to the telecoms sector with a current
transparent and predictable environment for
foreign equity ownership limitation of
business. Sectors that will benefit from
49% being phased out over four years
WTO membership include:
from accession. Russia has agreed
Automobiles. WTO membership will to abide by the WTO’s basic
halve car import duties to 15% by 2019. telecommunications agreement aimed
Import duties for trucks will fall from at promoting fairness and competition.

4


The rise of the “We believe in Russia’s huge Global consumer
Russian consumer long-term potential, that’s companies using
why we continue with Nestlé M&A to tap growth in
Substantially increased earnings and
low income tax have boosted spending investments into the consumer spending
power in Russia’s underpenetrated development of local
consumer market. Russian consumers
have the highest disposable income
production facilities.”
and fastest spending growth of all Stefan De Loecker, Chief executive officer of
Nestlé Rossiya.
BRIC markets (see figure 4).
Source: “Nestlé to Create a Greenfield Factory in
Unbranded goods dominate total Vladimir Region,” Nestle press release, 15 June, 2010,
consumption at low levels of household www.nestle.com
income and for essential goods and
services. However, as income starts to
rise, the preference for branded goods
increases and at affluent levels,
premium brands attract greater
market share (see figure 5).

Foreign brands and companies
including BMW, Nivea, Adidas, and
Sony are taking advantage of the
growth potential for international
brands in the discretionary space.

Figure 4: Russia has the highest proportion of high income households and fastest rate of
consumer spending in the BRICs
25%
% of households earning >$2,000 per month
Average growth in consumer spending 2000-2010
21%
19% 19%

13%
12%
10% 10%

Russia China India Brazil

Source: World Bank and Credit Suisse Emerging Consumer Survey 2012
5


Stable demand for locally-branded with total investment in the country
Foreign companies essential goods and services across the adding up to more than US$12 billion
income curve is driving acquisition in the past two decades.
attracted to activity by foreign companies. PepsiCo’s
well-positioned 2010 acquisition of Wimm-Bill-Dann

local brands gave the company ownership of two Figure 5: Brand market penetration
leading dairy brands. PepsiCo’s according to income group
products are now sold in 98% of retail
outlets across Russia. Nestle has been 60%
% penetration at lower income
linked to the potential acquisition of % penetration at higher income
Russian baby-food and juice producer 50%
Progress, having already made
acquisitions in Russia (for example, 40%

Ruzskaya Confectionary Factory).
30%
Foreign companies are looking for
local brands with a strong market 20%

position, growth potential and
positioned to take advantage of the shift 10%

from unbranded to branded products.
0%
For example, Russia accounts for Dairy: Autos: Cosmetics: Sportswear: TV: Fashion:
about 40 per cent of Carlsberg’s Domik v
Derevne
Lada Nivea adidas Sony Zara
(Renault) (Beiersdorf) (Industria de
sales. The brewer is close to finishing (PepsiCo) Diseno Textil

a US$1.2 billion purchase of minority
stakes in its local subsidiary, Baltika, Source: Credit Suisse Emerging Consumer
Survey 2012

Sporting success for Adidas
Adidas, the world’s second largest corporately owned stores and 13,000
sporting goods manufacturer, employees (Nike currently has around
expects the Russia/CIS region to 100 stores in Russia). The company has
become its third largest market its head office and distribution center in
globally behind the United States Moscow, and regional offices in seven
and China with annual sales of Russian cities. Adidas brands Reebok and
over US$1.3 billion by 2013. Sales Rockport also have their own chain of
are expected to increase by a stores in Ukraine and Kazakhstan. Adidas
double-digit average growth aims to have 1,200 stores by 2015.
rate annually to 2015.
Source: “Adidas Group sales in Russia/CIS to
exceed €1 billion by 2013 and grow double-digit
Adidas is the market leader for sporting yearly till 2015,” Adidas press release, 10 October,
goods in Russia/CIS with over 700 2011, www.adidas-group.com

6


A perspective on How should foreign
companies approach Russia? Interest in Russia’s
M&A trends in Russia Nick van den Brul: Working with a good
large consumer
partner is vital. High profile corporate activity market is driving
NorthStar is Catalyst’s partner in such as TNK-BP, an example of a 2003 joint
Russia. Mark Bond, NorthStar’s activity
venture that has resulted in widely reported
Chairman and Managing Partner, and shareholder conflict, can put off foreign
Nick van den Brul, Partner, have over 50 companies who do not yet have a foothold
years’ combined experience working in in Russia.
Russia. They discuss M&A trends and
share their insights about how foreign A suitable partner will ensure the investor
companies should approach Russia. retains control of investment and operating
decisions. The many German companies
investing in Russia are good at this as they
How would you describe the take a long view, even if they are eventually
M&A market in Russia? surprised by the size and quickness of the
returns. The recent Carlsberg bid for the
Nick van den Brul: There has minority stakes in its Baltika beer business,
been a significant increase in which has a 38% market share in Russia
inbound and outbound M&A and accounts for 40% of Carlsberg’s
enquiries this year. As Russian global sales, shows how this can pay off.
businesses mature we are All successful investments have been
seeing a shift away from new greenfield structured this way whether by purchase
investments to acquisitions of fully-fledged of the operating company or by acquisition
businesses, such as PepsiCo’s purchase of of the assets.
the Wimm-Bill-Dann food producers and
Unilever’s acquisition of Concern Kalina.

Mark Bond: Interest in Figure 6: Domestic activity currently Working with a
Russia’s large consumer dominates M&A but inbound and
suitable partner
market is driving a lot of the outbound activity is increasing
activity. We expect continued is vital
interest in acquiring businesses 80%

serving Russian consumers and general 70%
add-on acquisitions by companies which
already have a local presence. It is 60%

surprising that there is not more interest in
50%
the mining sector given the recent positive
changes in legislation regarding the bidding 40%
for licences.
30%

20%

10%

0%

Domestic Inbound Outbound

2010 2011

Source: Catalyst Corporate Finance

7


What should companies be officials and politicians. Also, the increasing
Rigorous due aware of when transacting number of Russians who go to European
and American business schools means that
diligence is critical a deal with a Russian many managers are now willing to look at
company? Western corporate incentive arrangements,
including share option schemes.
Nick van den Brul: Rigorous due
diligence to check whether a potential
partner has a disreputable background is
vital. Fundamental due diligence on critical What are the typical market
areas such as asset title, potential tax entry strategies used by
exposure or outstanding or potential
litigation should also be conducted. The
companies?
absence of GAAP or IFRS accounting Nick van den Brul: The auto market is a
standards (apart from in the financial sector) good example of how companies can work
means that a proper view of the operating successfully in Russia – imports initially, then
situation can only be achieved through a component manufacture followed by the
detailed review of the management development of sophisticated logistical
accounts. This can mean longer transaction systems. German companies have been
timetables. It is helpful that Russian sellers present in this sector and logistics
are open to the use of English law in M&A companies such as DHL and Rhenus
transactions and to the use of offshore have followed them. The infrastructure for
acquisition vehicles. successful business operations is getting
better every year.
Mark Bond: Strong personal relationships
are important. As with other emerging
economies, it’s important to build
relationships with local administrative

Case study: GRUMA’s acquisition of Solntse Mexico
In July 2011, NorthStar advised Solntse Mexico, US$9 million. The acquisition gave GRUMA entry into
Russia’s leading tortilla manufacturer, on its sale Russia. GRUMA had a presence only through exports
to Mexican tortilla producer GRUMA. Founded in prior to the acquisition.
1949, GRUMA is one of the world's leading tortilla
and corn flour producers and owner of the brand How the deal was transacted
Mission Foods. The company has operations in the The deal involved multiple jurisdictions, cultural and time
US, Mexico, Venezuela, Central America, Europe, differences. The Mexican management of GRUMA dealt
Asia and Australia and exports to 105 countries. through their American subsidiary based in Texas,
GRUMA has approximately 20,000 employees USA, the legal jurisdiction was the law of England
and 96 plants. and Wales with the legal firm based in London, while

Solntse had its holding structure in the British Virgin
Reason for acquisition Islands and
Over two thirds of GRUMA’s sales come from its non- on-the-ground
Mexican operations. Solntse Mexico introduced tortillas operations in
and corn chips to the Russian market and grew to Russia.
become the market leader with net sales in 2010 of

8


What types of companies are
Russian investors acquiring? Russian companies
looking overseas to
Mark Bond: There is a strong interest in
buying companies in natural resources and acquire new
manufacturing. This is being driven by the
technology
desire to increase market access and
gain operating synergies, acquire trading
operations, and to acquire new
technologies. For example, the Russian
group Digital Sky Technologies acquired
stakes in a number of high-profile US
technology companies (Facebook, Zynga).
TNK-BP made a hinterland acquisition
buying Vik Oil in Ukraine and has made “80% of our business growth
other acquisitions internationally. Sberbank
acquired Troika Dialog in Russia and has is going to come from high-
also acquired a bank in Turkey, Deniz Bank. growth areas identified as
BRICs. Our footprint will
How is private equity correlate with the ring of
approaching Russia? growth in various places
Mark Bond: Private equity firms operating
around the world, providing
in Russia add a useful dimension since, like they have good open
the Russian partners and entrepreneurs, markets.”
they are interested at the outset in a clear
Lloyd Blankfein, Goldman Sachs chief executive
route to potential exit. Many Russian
St. Petersburg International Economic Forum, June 2012
companies lack financial sophistication and
this means that constructing exit strategies
in order to avoid a potentially costly dispute
is a key part of any investment.

There is now around US$5 billion of foreign US$5 billion of
private equity funds dedicated to
investment in Russia, as well as the large
foreign private equity
amount of investment by Russian-owned funds are invested
funds. For large deals involving a foreign
investor where the investment is greater in Russia
than US$100 million, the Russian Direct
Investment Fund (RDIF), established by
the Government in 2011, is a very helpful
development. We have already seen a joint
venture announced between the RDIF,
BlackRock, Goldman Sachs and Templeton
to invest in leading Russian companies

preparing for IPOs in Moscow.

9


Figure 7: Selected recent M&A transactions
Date Target Company Country Target Activities Acquirer Country Deal Value Deal Type
(US$m)

Jun-12 Stream LLC Russia Digital content Sistema JSFC Russia 15 Domestic
delivery services

May-12 Denizbank Turkey Turkish bank owned Sberbank Russia 3,542 Outbound
Anonim Sirketi by Franca-
Belgian Dexia

Apr-12 OOO BAW-Rus Russia Manufactures SUVs, Beijing Automobile China ND Inbound
Motor Corporation minivans Works

Mar-12 Open Joint-Stock Russia Engages in the Rusenergo Fund/ Russia 750 Financial
Company Enel generation and Russian Direct Acquisition
OGK-5 wholesaleof electric Investment Fund
power and heat

Mar-12 Natur Produkt Russia Over-the-counter Valent Pharmaceuticals Canada 185 Inbound
International, drugs, generics,
JSC and food supplements

Feb-12 JSC Tascom Russia Wireless broadband Moscow City Telephone Russia 55 Domestic
service Network

Jan-12 Facebook, USA Various US based Digital Sky Technologies Russia N/A Outbound
Twitter, leading online
Zynga companies

Dec-11 Concern Kalina Russia Russia's largest Unilever UK/ 694 Inbound
personal Netherlands
care company

Nov-11 RTS Russia Merger of two Russian Micex Russia N/A Domestic
stock exchanges

Oct-11 Plastic Logic UK Develops and RUSNANO Russia 150 Outbound
commercialises
plastic electronics

Aug-11 Lenta Russia Chain of supermarkets TPG Capital USA 1,100 Financial
Acquisition

Mar-11 Novatek Russia 12% stake in Russia’s Total SA France 4,000 Inbound
second-biggest
natural-gas producer

Feb-11 Wimm-Bill-Dann Russia Produces dairy PepsiCo Inc USA 1,356 Inbound
Foods OJSC. products, juices,
mineral water and
baby food

Oct-10 SevenTV Russia General entertainment Walt Disney Co. USA 300 Inbound
television channel

Jan-10 Vik Oil Ukraine Fuel stations and oil TNK-BP Russia/UK 302 Outbound
depots in the Ukraine

Source: Catalyst Corporate Finance

10


Prospects for M&A Legislative reform such as the Third
Anti-Monopoly Package and general Positive outlook
changes to civil legislation should all
Given the long-term drivers discussed
improve deal making conditions and
for M&A
above, we expect to see a rise in M&A
over the next 18 months. encourage inbound M&A.

WTO membership will prompt domestic
While the State retains overall control
consolidation in certain sectors,
of strategic sectors including oil and
especially in telecommunications,
gas (above a certain size), the
insurance and other financial services,
defence industry and certain areas in
while legislative and regulatory initiatives
infrastructure such as railways, there
should encourage inbound M&A.
are many opportunities to invest in
consumer industries, manufacturing, Further investment and acquisition
infrastructure and many areas of activity by private equity, especially
natural resources, such as coal, by those companies already active
gold and other metals. in Russia.
Given the strong outlook for local
brands in essential goods and services,
foreign companies will acquire local
brands.

Find out more
Catalyst and our partner firm NorthStar work with companies, owners
and entrepreneurs looking to access the fast-growing Russian market.
In particular, we offer:
Acquisition search assignments
Advice on structuring and completing deals
Information on sector trends and valuations
Access to corporate decision-makers and owners
NorthStar’s senior advisers have dedicated their careers to Russia and Central Europe
and have significant experience in completing deals.

Contact Mark Wilson,

Partner, Catalyst Corporate Finance +44 (0) 20 7881 2960

11

Award-winning international corporate finance advice
Catalyst’s focus is on advising management teams,
private shareholders and corporates on:
Buying businesses (MBOs/MBIs/BIMBOs)
Selling businesses
Searching for businesses to acquire,
both in the UK and overseas
Investment opportunities for
private equity firms
Maximising shareholder value
This is all we do and all we want to do. ‘Mid Market Adviser of the Year’ 2011

International experience
Through our international partnership, Mergers Alliance, we provide:
Access to overseas buyers International M&A Research
Local knowledge of M&A culture Identifying targets overseas
and tactics and executing acquisitions

www.catalystcf.co.uk

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Catalyst Russia Country Report 2012

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